You are in suit business. Usually you sell a suit for RMB 1,000 on a cost of RMB 800, so business is good.
One day an importer from Iceland called you for an order of 100 suits, paying ISK 70,000 (Iceland Kroner) per suit, delivery at 6 months later.
You checked the exchange rate: the price equals RMB 1,200 (ISK 10 = RMB 1), enough to compensate delivery and other extra costs. Besides, you're excited to open a new business line in Europe. So you decide to go ahead.
...Upon delivery, ISK depreciated to ISK 20 per RMB 1.
International business brings an additional risk, the currency risk. Unscrupulousness will blow things up, sometimes costly.
That's why I can never understand why there's the Forex trading business for individual investors. I can't see any legitimate purpose beyond pure speculation. And it's leveraged.
China's $1 trillion
This explains why it bogs my mind when looking at China's USD 1 trillion reserve.
It's accumulated over the years when China was running a large and rising trade surplus with the US. The 2007 Current Account (I don't know what it is) stood at around $300 billion, or 7% of China GDP.
The nature and the sheer number makes it a bit larger and more complicated issue than the suit business. It seems both side consider the imbalance more a prob.
Prof. Wu spoke about it recently from the China side (吴敬琏：解决内外失衡的出路在于推进改革，实现增长模式的根本转变). You cannot find a more educating explanation. Warren Buffett also expressed his concern on it.
However, more questions remain. For example, when RMB appreciated 10%, does it mean that the reserve has lost $100 billion in value? Now China is pegging RMB to the dollar, how should China manage the Forex policy in the future?
Most importantly,
How should China spend the Money?
Right now, China is holding a huge amount of US treasury notes, using the US as a bank while trying to figure out how to spend the lump sum.
Chinese economic development has in a sense taken a route of Japan (and I have to say that it's not necessarily a good sign). It may help to take a look at Japan.
Japan was running trade deficits and accumulating foreign reserves. Besides holds a big sum of US treasury notes, it's been in a shopping spree around the world. Overall, it holds $3 trillion in financial assets around the globe, plus a FDI position of an additional $1 trillion. It bought the Rockefeller Center and Columbia Pictures.
Can China do that some day? Will China do that?
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